Century Aluminum Company (CENX) Q4 2016 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Century Aluminum Fourth Quarter 2016 Earnings Call. At this time, all lines are in a listen-only mode. [Operator Instructions] And as a reminder, this conference is being recorded. I'll now turn the conference over to Investor Relations Manager, Peter Trpkovski. Please go ahead, sir.

Thank you very much, Kathy. Good afternoon, everyone, and welcome to the conference call. I'm joined today by Mike Bless, Century's President and Chief Executive Officer; Erich Squire, Senior Vice President of Finance; and Shelly Harrison, Senior Vice President of Finance and Treasurer. As a reminder, today's presentation is available on our website at www.centuryaluminum.com. We use our website as a means of disclosing material information about the company after complying with Regulation FD. I would also like to remind you that today's discussion will contain forward-looking statements related to future events and expectations, including our expected future financial performance, results of operation and financial condition. These forward-looking statements involve important known and unknown risks and uncertainties, which could cause our actual results to differ materially from those expressed in our forward-looking statements. Please review the forward-looking statements disclosure in today's slides and press release for a full discussion of these risks and uncertainties. In addition, we have included some non-GAAP financial measures in our discussion. Reconciliations to the most comparable GAAP financial measures can be found in the appendix to today's presentation and on our website. With that, I'll hand the call over to Mike.

Thanks very much, Pete, and thank you to all of you for joining us this afternoon. If we could turn to Slide 4 please, we will get right into an overview of the last couple of months. Importantly all the facilities were stable during the fourth quarter and into 2017 and the operations performed generally very well. The few operational issues that we have faced at Sebree and Grundartangi over the summer quickly corrected and these two excellent plants are back to performing as we come to expect. And I will give you more detail on the operations in just a few moments. Moving on the financial results for the quarter, if you had a chance to look were favorable. We saw strong topic conversion and good cash flow in this environment. We believe we got an aggressive cost structure now in place and we are confident that we will result in strong cash flow conversion in the current or an improved industry conditions. To remind you most of our sales are priced at least two months prior, so we will see the impact of the current pricing environment in Q1 and even more so in Q2. And in just a few minutes Erich and Pete will provide some detail on the quarter that just ended, as well as our expectations for 2017. Moving along, we saw some important progress on our fair trade efforts during the last months pardon me - as you likely saw in early January the U.S. government brought WTO case taking China they are legally subsidizing its primary aluminum industry. The fact here are relatively straightforward, since the early 2000 the Chinese Government directed a massive build-out of its primary aluminum industry. During this time period their production of primary aluminum has gone from 2 million tons to over 30 million tons, as 10% of the global total to 55% today. During that same period, annual production growth in the rest of the world has averaged just 1%. Remarkable growth has been achieved through tens and tens of billions of subsidies following under WTO rules. Significant amount of those subsidies have been provided in the form of below market financing with various means I will list a couple for you. Just in provision for capital to entities unable to garner market base financing otherwise, loans and terms significantly favorable to market terms, sale of assets to government entities far above market value and similar measures. In addition there has been tens of billions of dollars in other forms for example free land, tax abatement and other measures and of course subsidies on coal, other fuels and other inputs like electric power, alumina. Many of these subsidies are hidden, in fact they are openly advertised we have seen curtailment announcements that have quickly been resented upon seeing the subsidy from a government entity. One major publicly traded producer even has a line item on their financial statements entitled subsidies from the government. We have recently seen a significant development on the case as you have probably seen several governments have asked a joint WTO case, these include the European Union, Canada, the Russian Federation, Japan and we believe this is tangible acknowledgement the global industry believes that problem is there and very significant. The trade laws were enforced to convince that significant capacity in production will quickly be shattered. Shelly will speak to you in a minute about the current industry dynamics and by inference what impact the enforcement of the trade laws could have on the supply demand balance. Okay, moving on we have seen some developments during the last couple of months on several of the Company's other strategic issues. As you may have seen a couple of weeks ago, we completed the disposition of the Ravenswood West Virginia smelter site, those of you that follow the industry for some time now this was one of the oldest operating smelter on at shot. In fact Ravens was Aluminum Company was the predecessor to what eventually became Century Aluminum. Gradually the plan had to be curtailed during the financial crisis and that we did reopen. It was especially disappointing as we had a lot of support, the leadership of West Virginia expanded great effort to try to help create the conditions in which the plant could restart. And for many reasons we are really pleased that the buyer intent to maintain an industrial operation at the site. We believe the terms of the transaction are good, the price compares favorably to recent sales of curtailed smelters and the buyer assumed all the liabilities. On a related development as we told you about in October, we have reached a preliminary settlement of the retiree medical litigation in West Virginia and that has now been submitted to the court and exactly those same terms. As soon it is approved by the court that would be finalized most likely later in 2017. Moving along, we had a disappointing result to the second arbitration regarding one of the original power contracts for the Helguvik project in Iceland. As you may recall those contracts were originally signed in 2007. Unlike the first arbitration panel in 2011, this panel ruled that the conditions to the contract were not going to be fulfilled unless that contract is now void. Second contract is still valid and since 2009 we have been taking some power under it for use Grundartangi and this will continue. We do continue to believe that at some point this project should make sense. Sufficient power resources appear to exist in areas deem sensible to develop but of course Iceland as a society needs to decide when and how to develop that power and of course what is used. Given all of that we will continue to pursue this project. However U.S. accounting still requires to impair the carrying value of the asset at this time. That has a gradual impact to the balance sheet but no effect otherwise. We have no maintenance covenants of any type, no covenants impacted by this type of non-cash write down and of course it has no commercial or economic impact. Okay last an important development in our quest for fair treatment in South Carolina obviously with the goal of making our Mt. Holly smelter competitive. Let me just remind you of the background here, we are now purchasing and has been for sometime 25% of the power from Mt. Holly from the local power supplier added requirements. The prices at power is well over double to deliver price of the power we buy for the market for the remaining 75%. And when you put those two sources of power together, the weighted average price is just shy of 70 percentile on the global cost curve. The highest price by far paid by any U.S. smelter and obviously makes Mt. Holly uncompetitive. If we were able to purchase that last 25% from the market and obviously we are 100% exposed to the market, the plant would be nicely in the second quartile of the global power cost curve. As you know Mt. Holly is competitive in every other manner, value added products come for almost all of the plants production, we got a terrific customer base, production efficiencies are very good even in the company of more modern smelters and a lean cost structure. Most importantly at that plant we really do have a terrific and engaged group of employees. The power cost however overwhelms all that, so we must find a solution. Over the months and frankly over the last year or two as you know we have continued to propose a structure we believe is in the best alternative for Mt. Holly and for all the various constituencies. That structure is pretty straightforward and Mt. Holly would purchase all of its power from the market, that mean enough power to power the entire plant as you know only one of the two product lines is operating today. And fourth, transmitting the power to the plant, Mt. Holly would pay the local power company extended transmission just like everybody else pays. We believe the data clearly supports that this proposal is in the best interest of the power company and all the various constituencies but for reasons we can understand power company hasn’t seen it this way. So few weeks ago as we probably filed antitrust lawsuit, let me just give you a back up and give you the context of this for a minute and under federal and state laws in order for any entity and certainly the one like the local power company, in order for any entity to be exempt from the antitrust regulations, we need to clear couple of key hurdles and the most important one here are two, number one it needs to add pursuant to a clearly articulated state policy, and two it needs to be actively regulated. And if you think about if the law make sense, an independent expert body needs to have the authorities so the users on phase within unregulated monopoly and unregulated monopoly that’s acting far beyond the authority granted to it and its founding legislation that has no oversight by the state and its harming consumers and regrettably we believe that’s exactly what’s happening here. As local power company decisions are made solely by the management and approved by the Board of Directors, that includes important things like rate increases which would of course normally go to a detailed regulatory process and review and also includes matters like ours at Mt. Holly. As a reminder we went through exactly this in Kentucky several years ago we proposed the exact same structure for market access and the payment of the standard transmission tariff. The proposal was put to the Kentucky public service commission or regulated there and the PSC rule that our proposal was in the best interest of all. And for the past three plus years it's been working very nicely for everybody. Unfortunately the South Carolina Public Service Commission and other regulatory bodies have no authority over this local power company's conduct and thus we were forced to file this lawsuit and we’re confident it will be successful. And with that, I’ll turn it over to Shelly for some thoughts on the industry.

Thanks Mike. If I could along to Slide 5, please, I'll provide some comments here on the industry environment. The cash LME priced average 17 ton per ton in Q4, which reflects the 6% increase over Q3. Since year end the aluminum price has continued to strengthen and its currently sitting at 18.80 per ton. Delivery premiums in both U.S. and Europe continue to strengthen Q4 averaging $7.6 per pound in the U.S. and $131 per ton in Europe. Similar to the LME price these delivered premium have about nice run so far Q1 and are currently sitting at $0.10 per pound for the U.S. Midwest premium and $165 per ton at the European Duty paid premium. As reported by CRU the global aluminum market experienced a deficit of about 725,000 tons for 2016. Excluding China, the aluminum market was short about $1.2 million tons by excess supply from Chinese producers offset a meaningful portion of this western world deficit. We continued to see good demand growth in 2016 with the 5.3% increase in global consumption year-over-year, Chinese demand growth of 7.4% was better than anticipated was continued strength from construction sector. Global primary aluminum production was up 3.1% in 2016 driven by start-ups and restarts in China towards the back half of the year. There has been a significant amount of speculation recently that Chinese producers reforced to curtail aluminum production in heavily polluted region. These environmentally driven production get could impacted much as 20% of the global aluminum supply during the heating season month of November through March. Even if these temporary curtailment actions due take place, China still expected to be in a meaning surplus position for 2017. There is also significant speculation in the market about trade remedy is may be imposed on the Chinese aluminum. As Mike mentioned, the U.S. government has solid trade case with the world trade organization in China providing massive illegal subsidies to its aluminum producers. The European Union, Canada, Japan and Russia have all joined the case demonstrating the global effect of China's unfair trade practices. Its early days of process but we believe this is the meaningful step for its creating a level plans to all of the aluminum producers. Over the last many years there has been lot of discussion about rationalization of Chinese production capacity. And we always highly skeptical of cut backs actually occurring given the historical track record. We're cautiously optimistic that the actions in contemplated today we’ll have a meaningful impact on our market given that this is no longer solely dependent on China self regulating but rather a global movement with strong support at the highest level of government. Absent in meaningful reductions in Chinese production, most industry experts are forecasting the global aluminum market with a recently well balanced in 2017 with the sizable deficit in the western world even gap by the ongoing surplus in China. Okay, just a couple of quick comments on the Alumina market before I hand it back to Mike. Alumina prices continue to increase over the fourth quarter, and ended the year close to $350 per ton in reaction to expensive caustic soda and coal prices, as well as logistical constrains in China. Similar to Aluminum, there’s been a significant amount of discussion around seasonal cutbacks of Alumina production in heavily polluted regions of China. However, we are anticipating downward pressure on the Alumina price near term in reaction to Chinese refinery restart and startup in 2016 and early 2017. And with that, I’ll hand it back over to Mike.

Thanks Shelly. If we can turn to Slide 6 please, let me just make a couple comments on the operations during the quarter before we get right to the financial results. As you see here, we generally had a very quarter in safety performance. All the plants continue to make continuous improvement. As you may remember in October when we talked to you, we were especially proud of Grundartangi and Sebree as they avoided serious injuries during the operational excursion during the summer months. And this performance has continued really well at Sebree. At Grundartangi which you're looking at there is only one more incident Q4 over Q3. So we’ve got a lot small numbers working there, but generally good results from all plants. Moving down, good performance also on hot metal production which you see there as Hawesville is down less than 1% quarter-to-quarter due to a slight increase in self-failures in December, and that problem has been corrected very quickly. We are now at full strength at Hawesville in terms of all the sales being operating. Production metrics as you see is strong across the businesses and importantly good performance in conversion cost which led to strong profit conversion. And again, this gives us confidence that we’ve got the cost structure thrive in this higher pricing environment. As you see, Sebree in particular did an excellent job in controllable cost. Give you a couple of example, labor costs were down 15% quarter-to-quarter, and maintenance and supply cost were down 40%. Mt. Holly as you can see is continuing to perform well and that performance is all the more impressive when you think about the environment of uncertainty in which the employees are living at that plant. Again, this cost performance underpins our view that the company is really well-positioned as the trade efforts and other factors lead to an improving commodity price. With that, I’ll give to Erich who will take you through the results for the quarter and for the full fiscal year. Erich?

Thanks Mike. Let's turn to Slide 7 on the presentation and I can walk you through the fourth quarter results. On a consolidated basis global shipments were up about 1.5%, and net sales were up just shy of 2% quarter-over-quarter. Next I’ll give you some market pricing data all of which are on a two-month lag basis. Cash LME pricing was up 3% quarter-over-quarter. Looking at U.S. pricing, the Midwest premium was down 15%, but when combined with the LME movement resulted in the Midwest transaction price up by 1% or about $15 a ton. U.S. realized pricing was also up in line with these market movements. I would note that value-added product premiums in the U.S. remain depressed in Q4 as was the case in Q3 and we expect this to continue well into 2017. Looking at pricing for the Atlantic operations, the European duty paid premium was down 1%, but when combined with the LME movement, resulted in a European transaction price up 2% or about $40 a ton. Atlantic realized pricing was also up in line with these market movements. Of course, the recent positive market movements in the LME and regional premiums that Shelly mentioned earlier, will flow to our results in Q1 and Q2 due to our sales price lag. Turning next to operating profit. For reporting and adjusted EBITDA of $12 million this quarter, which is an increase of $17 million when compared to the adjusted EBITDA loss of 5 million for the third quarter. EBITDA adjustments in this quarter included an impairment charge related to the Helguvik project, and a non-cash adjustment to the carrying value of inventories. As Mike discussed earlier, the $152 million impairment charge is non-cash and required under GAAP accounting as a results of the unfavorable arbitration. Although we continue to pursue and explore options to secure power in order to move forward with this project at some point in time, the entire value of the investment during the fourth quarter. Next I’ll walk you through the major items driving the increase of $70 million in our adjusted EBITDA for the quarter. Market factors contributed a net $4 million increase with favorable all-in aluminum pricing, power prices and raw materials and partially offset by higher Alumina prices. Sales volume and product mix contributed net $2 million favorable primarily on higher sales volumes. Finally, reduced operating cost across all smelters contributed $11 million favorably, most significantly at the Sebree facility as Mike mentioned. I would like to make one comment on the adjusted net loss this quarter, we have seen improvement there of $0.19 on adjusted earnings per share. The addition of course to the Helguvik impairment charge and inventory adjustment referenced earlier we adjusted net income for $7 million discrete tax charge. This charge was a non-cash balance sheet adjustment associated with expiry of Grundartangi tax agreement as a result Grundartangi tax rate will increase from 18% to the statutory rate of 20% effective January 1, 2017. Looking next to liquidity, we have no outstanding borrowings under our revolver other than letters of credit. We ended the quarter with $132 million in cash and $100 million of availability under our revolving credit facilities. The facilities are secured by both accounts receivables and inventories and availability under the revolver will fluctuate as our working capital levels move during the year. Turning now to Slide 8, we will take a look at cash flow during the quarter. Cash increased this quarter by $14 million. Capital expenditures were $9 million, we had a net cash inflow of $6 million from taxes as a result of an Iceland holding tax refund of $10 million received at the quarter. We made our second semiannual interest payment of $10 million this quarter and saw $15 million working capital improvement primarily associated with favorable timing of shipments and payments year end. I would also note that on balance, we expect to have seen increase in working capital starting in the first quarter of 2017 as a result of routine changes in payment terms on some of our commercial contracts. If we move to Slide 9, we can look at full year performance. On a consolidated basis global shipments were down about 20% due to U.S. production curtailments made during the fourth quarter of 2015. Net sales were down just over 30% year-over-year attributable to these production curtailments, as well as unfavorable market pricing. To give you some quick market pricing updates all of which again on a two month lag basis. First cash LME pricing was down 11% year-over-year, looking at U.S. pricing the Midwest premium was down 48% which then combined with the LME movement resulted in a Midwest transaction price down by 17% or about $350 a ton year-over-year. Looking at pricing for Icelandic operations, the European duty paid premium was down 52% which when combined with the LME movement resulted in the European transaction price down 17% or about $340 a ton year-over-year. Turning next to operating profit, we are reporting an adjusted EBITDA of $29 million for 2016 which the decrease is $71 million when compared to an adjusted EBITDA of $100 million for 2015. EBITDA adjustments in 2016 include an impairment charge related to Helguvik project, charges related to the closure of the Ravenswood facility and non-cash adjustments to the carrying value of inventories. Next I will walk you to the major items driving the decrease of $71 million in our adjusted EBITDA for the year. Market factors contributed net $90 million of the decrease, lower aluminum pricing was partially offset by reduced Alumina and other raw material costs. Reduced operating costs across all smelters contributed $19 million favorable due to significant operational cost reductions made during the year including those associated with curtailments. Turning now to Slide 10, we will take a look at cash flow during the year. Cash increased by $17 million, capital expenditures were $22 million, we paid net taxes of $4 million and interest payments of $20 million during the year. We received one-time payment of $13 million associated with the purchase of the Mt. Holly facility and so $21 million working capital improvement. Looking at the year-end numbers on balance, we went into 2016 with the modified operating configuration and unfavorable year-over-year market conditions but we are able to reduce operating costs and still generate positive cash flow. With that, I will pass to Pete to speak to some of our expectations for 2017.

Thanks Erich. If you could turn to Slide 11 please, I will take you through the company's expectations for financial measures in 2017. Sebree and Grundartangi continue to run at full capacity while Hawesville and Mt. Holly were at 40% and 50% respectively. As in prior years, we give you our expectations for the premium steel on value added products over standard rate aluminum. We estimate approximately $180 per ton over the LME and original premium on average over just over value added tons not a weighted average overall tons. As Erich mentioned, product premiums in the U.S. remain depressed and we have updated our product mix accordingly to maximize our margins in this environment. Now moving on to some of our largest cost components, Power and Alumina. First the Power, we use the forward screen of MISO, Indiana hub for Kentucky energy prices that result in a delivered price in the upper $30 per megawatt hour. Year-to-date delivery prices averaging the low to mid 30 as a result of mild winter conditions in the U.S. Midwest. In South Carolina we use the Henry hub natural gas price of $3.23 per Mmbtu prices that also subside in the U.S. Southeast and gas prices have decreased to below three. Just to remind you that in South Carolina as Mike mentioned that only implies the 75% of their power requirements. On Alumina we assumed a $300 per ton Alumina index price in 2017 all of our requirements will now be phrased on the index, as opposed to portion being phrased as a percentage of LME as was the case historically. This change increases our sensitivity to movement in the LME price to every $1 per ton movement in the LME commodity price, our annual EBITDA is now impacted by $62 million. You can find this in the rest of our sensitivities to premiums, power and Alumina on Page 18 in the appendix of our slides. Using those market assumptions on power in Alumina, as well as the regional premium described in out footnotes, we’ve updated our forecast for cash cost. Similar to prior years, we present on net cash cost net of all premiums received above the LME and is directly comparable to the LME price. So if we take the LME and deduct our net cash cost that resulted our expected cash margin per ton with no further adjustments needed similar to last year, we gave you the reconciliation of our net cash cost on Page 19 in the appendix. Okay, if we can turn to Slide 12 please, I will give you couple more time to turn it over to your questions. As Mike said earlier we have now finalized the sales of our Ravenswood facility and we receive proceeds of approximately $15 million in the first quarter of 2017. We will pay $5 million later this year as a result of the retiree medical settlement and pay the remaining $18 million evenly over the course of the next nine years. Our SG&A is expected to be just under $40 million, $4 million of which is non-cash. Interest is flat year-over-year. Moving down to CapEx, similar to last year our expected spend between $25 million and $30 million of which $10 million is related to maintenance spent. On taxes, we continue to expect our U.S. NOO to shale through essentially all of our U. S taxable income other than some modest pay taxes. In Island as Eric mentioned, we will accrue at a rate of 20% going forward. Lastly our consolidated cash flow breakeven using all the items just discussed is $1665 per ton. As a reminder this is an LME direct equivalent number and represents our cash flow after maintenance CapEx, SG&A, cash interest, cash taxes and any other corporate cash outflows but excluding the discretionary CapEx. With that, we’ll take all of your questions. Kathy can you please start that please?

[Operator Instructions] And our first question is from Jorge Beristain with Deutsche Bank. Go ahead please.

Hi Mike, it's Jorge Beristain with DB. Maybe just a macro question first, all of the WTO trade case filing, how physically could ruling happened - I mean we are more familiar with U.S. Steel filings that physically slap a tariff on imported steel but how could this work in the world of aluminum. Could you walk us through the mechanics of what the WTO could accomplish in order to get the Chinese basically to control their excess production?

Thanks Jorge. There is no difference in steel I mean the remedy can come in lot of different - if you're asking what the specific remedy could be, yes it comes in any number of different flavors. As you say, Terracotta is combination of the two really is there - the spoke is a fancy word, but there's no specific formula here that the WTO has to use.

But does the WTO then leave that to the local commerce department of each country to enforce? I'm just not understanding how the -

No, absolutely not. It's the WTO ruling. Just to give you completely answers, So A, is the WTO ruling. The first thing that would happen before even the remedies will be decided is that the order would come - if it made it this far, we are hoping of course that there can be a negotiated settlement of some sort but if it got this far we've come for the subsidies to seize.

Okay. And then who would be in charge of enforcing that?

In charge of enforcing that would be the WTO. This all happened under the authorities of the WTO. Is that your question?

Yes. I’ll move on. On a micro level just in Iceland, could you just explain the trigger reason there for the right, you were saying that really nothing has changed, and you are maintaining the full optionality there to proceed with Helguvik. But could you just clarify what was the trigger that caused the write-down.

Yes, sure. And as you say, the leading to your question is correct. But going back to 2007, we signed two power contracts for Helguvik. There was a basis of the project obviously. There were two Icelandic power companies. They were 60% and 40% respectively of the power required for that project, the plant is designed which was a full pot line. One of those counterparties, I don't know if you remember Jorge or this maybe before you were following us - brought an arbitration in 2011 in essence trying to get the contract voided other details which I am happy to do and at that time, it was unsuccessful. The arbitration panel found that the contract was still valid, and that the parties should still work to satisfy the various conditions, blah, blah, blah. They brought the same, in essence, the same arbitration this time last year and regrettably the result was the opposite this time. The panel found that the conditions, because of the passage of time, hasn’t been satisfied and wouldn’t be satisfied. And thus under their contractual right, they voided the contract. So that was the trigger. We now only have one contract remaining, and just for 40% of the power that would be required. And thus there is no under the contract, as it existed, there is no sufficient power to build the plant. So we would have too out and acquire/procure significant amount of additional power in order to make the project viable. So that was the trigger. Very simple, we lost our power, to say it simply.

Okay, got it. I’ll hand it off. Thank you very much.

Thank you. Our next question is from John Tumazos with John Tumazos Very Independent Research. Go ahead please.

Thank you for taking my question. I am a little confused about the Chinese cutting output to reduce pollution during the cold weather months.

Yes.

The International Aluminum Institute data published this week had the Chinese metal output up 19% from a year ago, January.

Yes.

When are their curtailments wanting to take effect?

That’s a good question. You've heard what Shelly said, I don’t even think she had to read between her line - her words to say we are skeptical, period and Shelly, you want to expand on…

Yes. And I don’t think the discussion is about this winter heat is - 2017 for November 2017 to March 2018 is what people are really talking about.

We’ve seen this kind of thing before. John, you’ve been following the sector long enough to know that. Curtailments that have been promised is not announced, even announced as I said. That has not happened. That’s part of the problem. That’s part of why the surplus is there today, and driven by the subsidies this one feels a little bit - and whether it's in response to the WTO case settlement filed in [indiscernible] like there maybe a little bit more behind it but we are certainly mode here but Shelly that's a good answer, if it happens it prospect of.

Thank you.

[Operator Instructions]

We appreciate everybody's time. And we look forward to speaking with you over the coming months. Good evening.